I was really surprised to read that someone would be upset about having their gift quilt entered in a contest, but if she's not interested in quilting, she likely doesn't realize that this is very common.
To her, it probably seems like it's not fully a gift, since the MIL uses it for the other purpose. It may feel to her like she's getting castoffs, fallout from the woman's hobby. If she and the kids don't need or want quilts, to be given them instead of gifts thoughtfully chosen to please them really isn't a gift then.
That said, it's not like the MIL is carelessly cranking out quilts. If they're contest quality, she's put thought and work (and probably a lot of love) into making them. Someone does need to set this DIL straight on that.